On April 19, 2021, New York Governor Andrew Cuomo signed into law the FY 2022 budget (S2509-C/A3009-C), which includes a Pass-Through Entity Tax (“PTET”) election. Similar to the New Jersey Business Alternative Income Tax (“BAIT”), this will allow businesses in New York a workaround to the $10,000 state and local tax (“SALT”) deduction limitation imposed by the Tax Cut and Jobs Act (“TCJA”).
The fiscal year 2022 budget legislation is wide-ranging and ushers a number of changes to the state’s corporate and personal income tax provisions. Some of these changes include an increase to personal income tax rates, an increase to corporate income tax rates, the postponement of the scheduled phase-out of the business capital tax, and the creation of the pass-through entity tax election.
Since the enactment of the TCJA, we have seen a flurry of states enact pass-through entity taxes with the intent to circumvent the SALT limitation. As we wrote about on April 13, 2021, “The Rapidly Changing Landscape of State and Local Pass-Through Entity (PTE) Taxes,” in the recent years there’s been a significant development of states enacting PTE income taxes. This trend continues with the recent passage of New York’s PTE tax with the expectation more states will pass equivalent legislation in light of IRS Greenlighting the SALT Deduction for Pass-Throughs (IRS Notice 2020-75), as we wrote about in November of 2020.
The PTET, which is effective for tax years beginning January 1, 2021, is an annual electable entity level tax for pass-through entities. The election is an irrevocable election and is due on March 15 of each tax year, which is also the due date of the first quarter estimate. However, for 2021, the legislation allows for the election to be made by October 15, 2021.
Some of the key highlights of the legislation include:
- Pass-through entities (PTEs) eligible for election generally include partnerships, limited liability companies (i.e. treated as partnerships or S corporations for federal income tax purposes) and New York S corporations;
- The pass-through entity tax is imposed for each taxable year on the taxable income of every electing PTE at rates ranging from 6.85% to 10.90%;
- PTE taxable income is defined as:
- For partnerships, all income from New York sources included in the taxable income of a non-resident partner and all income included in the taxable income of a resident partner;
- For S corporations, all income derived from New York sources (for both resident and nonresident shareholders);
- A PTE Tax Credit:
- Is allowed as a refundable personal income tax credit for the electing partnership’s direct partners or members or the S corporation’s direct shareholders. As such, the legislation appears to only benefit Article 22 taxpayers, which are subject to New York personal income tax;
- Resident and nonresident taxpayers would be entitled to a credit for their share of the PTET that was paid on their behalf, which if the PTET credit for an individual exceeds their personal income tax, the excess would be refundable;
- The legislation does not appear to disqualify a PTE from making the election with entity partners (i.e. corporations or partnerships), but the PTET would only be computed with respect to the distributive share of the Article 22 taxpayers, which are subject to New York personal income tax;
- The legislation suggests that the allocation provisions would track the present-day partnership allocation formulas for electing partnerships and present-day corporate allocation formulas. As such, partnerships would calculate New York source income using cost of performance rules and S corporations would calculate New York source income using market-based rules. However, further guidance from the state may be necessary;
- The PTET tax return would be due by March 15th for both calendar and fiscal year taxpayers. For fiscal year entities, the return is due on or before March 15th following the close of the calendar year that contains the final day of the entity’s taxable year;
- Estimated taxes are required for calendar year taxpayers in four equal installments on March 15, June 15, September 15, and December 15;
- The electing pass-through entity will not be required to make estimated payments for 2021. As such, PTE owners may still be required to make estimated payments without taking into account of the PTE credit;
- The election is required to be made by:
- For S corporations, by any officer, manager or shareholder who is authorized under the law of the state where the corporation is incorporated or under the S corporation’s organizational documents to make the election;
- For partnerships, by any member, partner, owner, or other individual with authority to bind the entity or sign returns pursuant;
- Separately, for purposes of resident state credits, New York residents will be allowed a resident credit against their personal income tax due for all other “substantially similar” state PTE taxes paid to other states by the PTE.
Let’s Talk About Pass-Through Entity Tax
State PTE tax legislation and proposals have been on the rise since the passage of the TCJA, and it’s expected to continue to trend upward with IRS Notice 2020-75. What is unique about New York’s legislation in contrast with other states with PTE tax is that the PTET election could still be advantageous for partnerships that are conducting significant business outside New York, but have New York resident partners with minimal or no New York source income.
While we will continue to monitor New York Department of Taxation and Finance’s further guidance on this, businesses should weigh the potential benefits along with the risks in determining the right course of action. As a number of different factors will play a role in businesses considering making elections into entity-level taxes, it is crucial all of the various considerations are modeled out. A key consideration may be owners state residency.
Author: Zhoudi Tang, CPA, MST | firstname.lastname@example.org
Business Tax Services